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Yesterday, we ran the first installment of an interview with Eli Lilly CEO John Lechleiter, in which he says the pharmaceutical industry is breaking out of its current rut, and is beginning to get more productive at pumping out more innovative new drugs.

Today, we follow up with the second half of the interview, which includes some interesting thoughts on “open innovation” that were prompted by a question from Twitter.

Xconomy: Is it possible to get too big as an organization to innovate? Is this partly why you’ve resisted the urge to do a mega-merger like some people have said they want to see?

John Lechleiter: We’ve done lots of studies, several huge studies in the late 1990s that date back to the pre-Prozac patent expiration. We fail to see a connection between size and innovativeness. I’m not smart enough to say that it’s best to be this size or that size, but obviously if you’re a $50 billion-a-year company or a $70 billion-a-year company, growing 10 percent a year means you have be a lot more innovative in an absolute sense than a company of Lilly’s size at $23 billion in revenue. We study this question of how to create a company that’s really innovative. I don’t think there’s an easy answer, otherwise the industry would have locked and loaded on it.

I do think there are things that matter. I think co-location is important. Hiring talented people and keeping them. There are cycle times of 10-15 years in this industry. I’ve been at Lilly for 32 years, and I’ve only been around the horn two or three times.

We still think we hire people for careers. That may sound corny to some people, and fly in the face of what we hear. I think we heard today (from University of Washington president Michael Young) that people can expect to have three different careers. But we aim to give people a reason to want to stay and want to be productive at Lilly, and that they can stay and realize their career ambitions. Obviously there are lots of other things that go into the equation. Things like what kind of leadership and management is most conducive to innovation. I can tell you when I talk about commitment to innovation, this is what our scientists want to hear. They want to know they have a CEO who is committed to what they do. I think it matters a lot. I’m betting on them, and they know it. And I think it’s a good bet.

Eli Lilly CEO John Lechleiter

X: You made a reference earlier today about the pharma industry’s need to better communicate what it does to the broader public. But I have to challenge that, and bring up some of the major ethics problems this industry has had over the years, and which the public hears a lot about. Whether it’s hiding bad data, or bribing clinical researchers overseas to get good data, or pay-to-delay agreements with generic companies, tax evasion, off-label marketing, and on and on and on. My question to you is what are one or two things that the industry can do, that are legitimate things, that could restore some public confidence?

JL: First of all, transparency. We were the first company, in 2004, to post our clinical trial results online, whether they are positive or negative. Now everybody does that. It’s interesting to me that you don’t hear much anymore about concerns over clinical trial data not being shared. Or about negative results not being shared. It doesn’t mean, Shazam!, the problem goes away. But I think most people are reasonably assured now, through clinicaltrials.gov, and through other disclosure mechanisms, that the light in the room is on, and there is widespread knowledge of what trials have been started, which ones are running, and what the results are.

It’s interesting to me to think back 10-15 years ago, about all the reasons we didn’t want to share that information, and most of that revolved around concerns about proprietary information. We have shareholders to think of, and competitive issues to manage. It turns out that wasn’t such a problem. Transparency around clinical trials is something we have been able to manage, and we’ve been able to maintain necessary protection around the intellectual property that we need.

Secondly, we have to show we can be trusted. We need to recognize that some people’s view of pharma is going to be colored by past transgressions. People can point to a failure here or there, but in the long run we have shown we can be trusted partners, based on our behavior. We put in a state-of-the-art, robust, and effective program within Lilly to ensure it’s more than words. We have an assurance that all 35,000 people across the company who work for us understand how it is we do business, and how the way we do business reflects on who we are, and how we are seen by the public.

The other thing I was talking about before (during the WBBA conference) is about doing a better job over time, putting in understandable terms, what we do, how we do it, and why we do it. Our business is very complex. It doesn’t lend itself to sound bites. When you say to people it takes $1 billion to bring a medicine to the market, can I explain that in 15 seconds? It’s very difficult to do. It’s hard to talk about why intellectual property is important. Some will say it keeps medicines from being widely available in countries where people can’t afford to pay for them. There’s a great discussion around that. The answer is IP doesn’t preclude that automatically. But having those debates, and being out in public as I was here today, and being willing to engage on tough and sensitive topics is something all of our leaders and all our companies frankly need to be more engaged in.

X: You also spoke earlier about the need to modernize the FDA to help improve innovation. What do you have in mind specifically?

JL: We need to pass (the Prescription Drug User Fee Act 5). So far, the proposals for PDUFA 5, which are supported by our industry, not just PhRMA, but also BIO, the association that represents smaller companies, are good. We want to see that supported by Congress, with hopefully a clean bill, before the end of the 2012 fiscal year. Because the FDA depends mightily on the resources that provides. There are other initiatives being talked about. Commissioner [Margaret] Hamburg and others are interested in what they can do to foster innovation.

What I tend to say is, ‘Look, we have an explosion of knowledge going on, and all these tools, and research networks. All of it augers for greater research output.’ So why have fewer medicines been approved in the last five years than in any five year period since 1979, when I joined Lilly?

X: Not to mention, this whole drought of new medicines has been occurring while a lot more money is being spent.

JL: Yes, a lot more money is being spent. But also, let’s not forget the unmeasured toll of human suffering. Nobody can ever argue for the medicine they were unable to use. Alzheimer’s really stands out. All of us are frustrated that there are very few effective strategies for slowing down Alzheimer’s. It’s a huge area of research, and a huge area of risk.

X: Is FDA the problem in your view? You’re talking about all the new tools, and new knowledge…

JL: I don’t like to lay a problem on anybody else. We have to own Lilly. And the biopharma industry has to own the challenge of improving research productivity. There are a number of areas, we’re suggesting, in which we can work with the FDA on the regulatory process. PDUFA covers some of that.

X: You guys recently got divorced from San Diego-based Amylin Pharmaceuticals on your diabetes partnership. Any comment on that, or any lessons learned from that collaboration that might apply to future collaborations?

JL: We’ve had a very successful 10-year collaboration with Amylin. We both brought the first GLP-1 product to the market, Byetta. We both brought the first once-weekly diabetes medicine forward, in the form of Bydureon, which is now approved and launched in Europe. As I said in the announcement a couple weeks ago, we both determined this is the best outcome for both companies. It enables Amylin to have full rights and full ownership to both of these assets, Byetta and Bydureon. It enables Lilly to continue to pursue our own entry in the market, potential entry, GLP1-fc (dulaglutide), which is in Phase 3 studies now—and to focus on other aspects of our diabetes business, including our insulins, and our partnership with Boehringer Ingelheim.

X: OK, I want to fire off a few questions from Twitter, which I asked readers to send me in advance of this interview. First, we have one from France in which a scientist is asking, “What are your views of CETP inhibitors and the competitive landscape?” He’s referring to drugs like Pfizer’s failed torcetrapib, and I know Lilly has a new contender now, that seeks to raise the “good” HDL cholesterol.

JL: Three have now reported out mature data, from Roche, Merck, and now Lilly. I think this approach to lowering LDL and raising HDL is potentially very interesting but remains to be proven in large scale trials.

JL: We’ve studied these for over 25 years, since we had the early Prozac trials. These trials can be very difficult because of the thing Matt points to, which is a pronounced placebo response. It can be more or less pronounced based on trial design. We’ve done a lot of work within Lilly studying what is the best way to design a study to make sure you’re getting a valid signal. But there’s no question that any time you’re studying a medicine for a mental health or psychiatric indication, you’re likely to get a placebo effect and you have to plan the study very carefully to be sure the data you get out is meaningful. These studies are certainly more hard to do than a study of a new anti-hypertensive, let’s say. But it’s an important field, and we have to continue to advance.

X:David Steinberg of PureTech Ventures asks, what was the math on the $300 million upfront for a PET tracer (Avid) and is it paying off? Any more like that on the horizon?

JL: Avid was one of the first companies our venture capital arm invested in. We had a view of Avid based on being an early investor. We also use the product, PET imaging ligand, in a couple of our late-stage studies for Alzheimer’s. This was used in Semagacestat, the Phase III Alzheimer’s program we discontinued, and solanezumab, which is still in Phase III. Our belief is this could be an important product for the field. It is a bit outside Lilly’s traditional therapeutic wheelhouse. We feel the price we paid was worth it, and it’s still a good investment. Obviously, we have not yet gotten it across the finish line, for approval with the FDA, but we are working to get that done.

X: Derek Lowe of In the Pipeline asks, what are your plans for “insourcing” chemistry? This has something to do with the arrangement you have with AMRI where some chemists who formerly were with Lilly are now working there, through an outsourcing operation that is close by.

JL: We are doing some insourcing of chemistry. What I’m most familiar with is some insourcing of chemistry at our labs in the U.K. We will be considering doing some of that in the U.S. I’m not completely current with that. But it goes back to what I said earlier. Over the past decade, Lilly and the industry have shifted from a monolithic model where we do everything, to start using the resources, brainpower, talent of others in various ways, including insourcing and partnering to get work done more efficiently and effectively.

X: Jonathan Mandelbaum, a scientist in Boston, asks for update on the open innovation platform. Any drugs successfully in-licensed?

JL: I’m not entirely sure what he’s referring to. We announced our Mirror Portfolio. We have two of these with external investors, where we are taking Lilly innovation and external innovation and putting it together into a preclinical development engine. The goal is to get those innovations into the clinic and do the necessary proof of concept studies in the clinic. And Lilly has the right to buy back the innovation from the investors. If that’s what he’s referring to, it’s too early to say how it’s doing.

The other thing he might be referring to is what we used to call PD2. This is something we launched 2-3 years ago, where we sign contracts with biotechs and academic institutions to screen molecules for them. We give them screening results, and it remains their property. There’s no charge for this. The only thing we ask is that if there is something of interest that comes from it, we have right of first negotiation. But if the negotiation can’t be completed, it’s their intellectual property to use as they see fit, for publication or other licensing opportunities. Several hundred institutions have contracted with us to do this, including many top academic institutions and biotech companies, as well as foreign institutions. We’ve just amped that up. That’s probably what he’s talking about. So far, and it’s been several years since we started it, but so far, we have two agreements we have signed with two institutions to take one molecule or a series of molecules into further development.

It’s a long-term play, long-term investment. It puts our toe in the water on more of an open-innovation platform. One of the interesting questions we ask ourselves is how can we take advantage of the Internet and electronic communications, how can we operate more effectively in a virtual world, instead of a brick-and-mortar world, to collect ideas and amass capital and solve some of these problems?

We started a company called InnoCentive in Andover, MA, which is sort of the eBay of science and engineering. In other words, you put a question out there and pay for the best solution. Whether it’s a chemical synthesis problem or an engineering calculation problem. That’s only one channel. We’ve since sold that company. But it’s one approach to a more virtual, multi-platform approach to innovation.

X: Last thing: One commentator (Adam Feuerstein of TheStreet.com) said I should tell you to resign. But another, John LaMattina, who used to run R&D at Pfizer, followed up and said “Ouch, this guy is trying to move Lilly forward by focusing on R&D. It’s unique among current pharma CEOs.”